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Saturday, July 28, 2012

Maximizing Your Investment Income

In the previous post, we discussed what income return is, how to identify and differentiate it from other types of returns.  In that post we covered the rationale behind making investment for income and the need to generate replacement income, more so if you are investing for retirement.
In general, a return is the money gained from your investment. For instance, if you buy a stock at $1000 and after one year you sell them at $1500, your return on investment is $500. You made a return on your investment because you sold your stocks at a profit. In percentage, your return is 50% ($500/1000).
A part from selling to realize profit, you may earn return if your investment generates some income on a regular basis. For instance you buy a residential house worth $100,000 and rent it out. The property then generates $10,000 in rent per annum.
In this case, you still own your property but receive a return of $10,000 annually. Therefore, your yearly return is 10 percent ($10,000/$100,000). It is this kind of return (income return) that is referred to as yield. Yield is the answer to “what guaranteed gain (return) will I get from my investment?”
Remember, when you are waiting to sell your property or investment position, the return is not guaranteed until the sale date. However, with regular steady income, you are sure of return.  Therefore, yield (income return) has no relation to the price of your property – whether it falls or goes up. It is all about receiving the money.
Weighing your investment Options
Yield concept is used in various investment decisions dealing with income driven investment options including bonds, rental property and even company stocks (in terms of dividends).
“Dividend Yield”, is simply an expression of your cash return (through dividends) if you were to buy the stock at that particular price.  The company issuing the share will have to pay you that dividend irrespective of the prevailing share market price. Therefore, if your investment objective is geared towards income, then yield is a vital parameter to look at when making investment choices.
Going back to our rental house example, assuming now you get an opportunity to buy another rental property for $500,000 and it will earn rent of $36,000 per year. A good amount of money, isn’t it?
You may be lured into thinking that this is more money ($36,000 compared to $10,000). However, the yield in this case is 7 percent ($36,000/$500,000) which is obviously lower than the 10% from the first property. Faced with these two scenarios, the best option (if you can access the required fund) is to buy 5 of the first units and earn $50,000 a year.
As said before, capital gains have their place in investment, but you will definitely require your investment to generate some income. The yield may be far more important to you than capital gains since it is this yield that will sustain you.
With all this in mind, it is therefore advisable to compare the different investment options available in terms of yield. This because you will get the most out of your investment through passive income as opposed to growing the asset value.

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